E-Books Rewrite Bookselling

ENLARGE

In 2000, crowds wait to buy the latest Harry Potter book at a Maryland Barnes & Noble store.
AFP/Getty Images

By

Jeffrey A. Trachtenberg

Updated May 21, 2010 12:01 a.m. ET

NEW YORK—In the massive new Barnes & Noble superstore on Manhattan's Upper East Side, generous display space is devoted to baby blankets, Art Deco flight clocks, stationery and adult games like Risk and Stratego.

The eclectic merchandise, which has nothing to do with books, may be a glimpse into the future of Barnes & Noble Inc.,BKS0.23% the nation's largest book chain.

For 40 years, Barnes & Noble has dominated bookstore retailing. In the 1970s it revolutionized publishing by championing discount hardcover best sellers. In the 1990s, it helped pioneer book superstores with selections so vast that they put many independent bookstores out of business.

The Future of the Book

The Journal explores how digital technology is remaking the book industry. See more at WSJ Topics: E-Books.

But the digital revolution sweeping the media world is rewriting the rules of the book industry, upending the established players which have dominated for decades. Electronic books are still in their infancy, comprising an estimated 3% to 5% of the market today. But they are fast accelerating the decline of physical books, forcing retailers, publishers, authors and agents to reinvent their business models or be painfully crippled.

"By the end of 2012, digital books will be 20% to 25% of unit sales, and that's on the conservative side," predicts Mike Shatzkin, chief executive of the Idea Logical Co., publishing consultants. "Add in another 25% of units sold online, and roughly half of all unit sales will be on the Internet."

Nowhere is the e-book tidal wave hitting harder than at bricks-and-mortar book retailers. The competitive advantage Barnes & Noble spent decades amassing—offering an enormous selection of more than 150,000 books under one roof—was already under pressure from online booksellers.

It evaporated with the recent advent of e-bookstores, where readers can access millions of titles for e-reader devices.

Even more problematic for brick-and-mortar retailers is the math if sales of physical books rapidly decrease: Because e-books don't require paper, printing presses, storage space or delivery trucks, they typically sell for less than half the price of a hardcover book. If physical book sales decline precipitously, chain retailers won't have enough revenue to support all their stores.

Some question whether book stores will go the way of music stores, which closed en masse once consumers could sample and download music digitally. Blockbuster Inc., the video rental giant, is struggling to reshape its business at a time when movies can be downloaded directly to digital devices.

Unlike music, the book industry didn't suffer dramatically from digital theft and, for years, couldn't figure out how to make money from e-books. There was no sense of urgency.

"It's fair to say that the leadership folks at the major trade publishers didn't believe until very recently that e-books had any economic life in them," says Arthur Klebanoff, chief executive of New York-based RosettaBooks LLC, an e-book publisher.

The success of Amazon.com Inc.AMZN-0.11%'s Kindle e-reader recently changed all that, proving to publishers that the e-books market was real.

But it wasn't until the arrival of Apple Inc.AAPL-0.87%'s iPad last month—with its promise of one day tapping more than 125 million iTunes customers—that the true potential of the e-book market became apparent.

At Barnes & Noble's superstore in Manhattan, generous display space is devoted to nonbook items like puzzles and games.
Johnny Simon for The Wall Street Journal

Google Inc. will join the fray in late June or July when it is expected to begin selling its own e-books.

"The store model is under pressure, whichever way you look at it," acknowledges Leonard Riggio, Barnes & Noble's 69-year-old chairman and largest shareholder. Over the next three to four years, Mr. Riggio says, a different, more diverse Barnes & Noble retail store will evolve, selling a variety of merchandise and serving as a showcase for digital products.

Mr. Riggio is suddenly under pressure to transform Barnes & Noble. Billionaire investor Ron Burkle, who has told associates that he believes the retailer's brand name has staying power, has recently increased his stake in the company to 19.6%.

In coming months, he's expected to wage a proxy battle aimed at influencing the retailer's direction.

Others are less optimistic about the future of brick-and-mortar retailers: "Their time is limited," Mr. Shatzkin says flatly. "I can't see how sales can do anything but continue to erode, and probably at an accelerated pace."

Borders Group Inc., the nation's second-largest book chain, saw same-store sales decline 14% at its superstores for the quarter ended Jan. 30. It laid off 884 people, more than 3% of its work force, last year, and now operates 175 Waldenbooks stores, down from 1,200 in 1992.

Once-thriving mall stores have largely vanished. Of the 797 B. Dalton Booksellers stores that Barnes & Noble acquired in 1987, only four remain. And the number of independent booksellers continues to fall.

Stores that are surviving are doing so by radically shifting gears. Indigo Books & Music Inc., Canada's largest bookseller, aims to transform into a "cultural department store" through the sale of nonbook items.

"The days of filling the shelves and just opening the doors are gone," says Heather Reisman, chief executive.

E-books have turned the economics of book retailing upside down.

ENLARGE

When it launched the iPad last month, Apple championed a new approach to e-book pricing. Earlier this year, most large publishers agreed to establish a so-called agency model, where the publisher receives 70% of the digital price while e-book sellers act as agents and receive 30%. While some best sellers remain at $9.99, many major authors are priced at $12.99 or $14.99.

For many digital booksellers, the new model is good news: Instead of having to pay publishers half, or $12.50, for the e-book edition of a $25 hardcover book, and then sell that book at a loss—for, say $9.99—to match Amazon's cutthroat prices, the bookseller now gets 30% of the newly-set $12.99 price, or $3.90. Since it hasn't paid anything for the title, it is ahead of the game.

But for Barnes & Noble, the model can't hide a brutal reality: $3.90 is a fraction of the $12.50 it now earns on a full-priced hardcover priced at $25. If e-book sales become a quarter to a third of the market, store revenue would plunge.

Faced with such a scenario, Barnes & Noble is re-examining its business model.

In March, in the most dramatic management change since it went public in 1993, the company named 39-year-old William Lynch, a newcomer with Silicon Valley roots, as chief executive. Mr. Lynch replaced Mr. Riggio's younger brother, Steve, 55.

After nearly 17 years of consistent growth, Barnes & Noble is stumbling. Revenue fell 3% to $5.12 billion for the fiscal year ended Jan. 31, 2009, while earnings dropped about 45% to $76 million.

The company is expected to report its second consecutive year of declining same-store sales when it reports results next month. Its stock, which closed at $18.58 a share Thursday, is less than half its peak four years ago.

Mr. Riggio isn't accustomed to such setbacks. Since he founded his first bookstore, the Student Book Exchange, in Greenwich Village in 1965, the native New Yorker has been at the vanguard of book retailing.

In 1971, he bought Barnes & Noble Inc., which consisted of a single store on New York's Fifth Avenue. Soon, Mr. Riggio helped champion discount best sellers, sparking the growth of hardcover books that today are the mainstay of the publishing business.

By the early 1990s, Mr. Riggio saw that superstores, with huge selections, represented the future of bookselling. Even though he'd earlier bought B. Dalton Booksellers, Mr. Riggio began cutting back on mall stores and opening new 100,000-plus title superstores.

When the fledgling digital book business emerged in the mid-1990s, Barnes & Noble was one of the first to embrace it. In 1998, it made a small investment in NuvoMedia Inc., maker of a handheld device called the Rocket eBook reader.

In what would prove to be the retailer's largest strategic blunder, Barnes & Noble abruptly pulled the plug on digital reading in 2003. E-book prices at the time—about $20 or more, compared to a $25 hardcover—turned off readers. And there weren't many titles to choose from.

"Was it us? Or was it that the market wasn't ready?" Mr. Riggio reflects. "It was probably a bit of both."

In hindsight, the move cost Barnes & Noble market share and momentum. "If they'd hung in there, they would have been able to build on their early mover advantage and expose their millions of consumers to e-books through the use of their stores," Mr. Klebanoff says.

In November 2007, Amazon walked through the digital door that Barnes & Noble had left open, launching the Kindle.

It would take Barnes & Noble two years to catch up and launch its own e-reader, the Nook. Today Amazon boasts 70% to 80% of the digital book business, analysts say, with the remainder divided between such rivals as Barnes & Noble, Sony Corp. and Kobo Inc.

Barnes & Noble wasn't just slow on the e-reader. Though it was clear the online book selling business was nibbling into book sales by 2005, the giant bookseller didn't dramatically redesign its website until October 2007. By then, Amazon had become the country's dominant online bookseller.

In mid-March, Barnes & Noble's board approved Mr. Riggio's choice for a new chief executive, naming Mr. Lynch, who had joined the company only 13 months earlier as president of Barnes&Noble.com.

Mr. Lynch, a veteran of the digital world, is seen as a change agent. A trim runner who favors open-necked shirts and dark suits, he joined Palm Inc., the pioneering hand-held device maker, in 2000, where he oversaw digital strategy and the website. In 2005, he joined Barry Diller's IAC/Interactive Corp., launching Gifts.com, followed by a tour at HSN Inc.,HSNI0.26% the television home shopping network.

Mr. Lynch is already shaking things up, hiring a team of executives from e-commerce and technology companies in a new Palo Alto outpost. He is going as far as to describe Barnes & Noble as "as much a technology company as we are a retail company."

His strategy is to use the one asset Amazon and Google can't match: Barnes & Noble's 719 superstores. Customers can test the Nook and get free original in-store content, such as a short story set in Italy by Alexander McCall Smith. Other in-store perks include free Wi-Fi service and free cafe offers.

Mr. Lynch has negotiated a deal with Best Buy Co.BBY0.53% to sell the Nook in more than 1,000 Best Buy stores. He says Barnes & Noble now has 1.2 million titles in its e-Bookstore and is now accessible on more than 400 different devices.

More From the Series

But Barnes & Noble faces deep-pocketed technology titans. Charlie Wolf, a senior analyst at Needham & Co., estimates that Apple will sell 5.5 million iPads in 2010, while Amazon will sell 3 million Kindles and Barnes & Noble will sell 1 million Nooks.

The future of Barnes & Noble's bookstores may boil down to one question: Will people prefer digital books as much as they preferred digital music? If that is the case, physical stores may all but disappear.

"I wouldn't write off retail book stores," Mr. Riggio says. "People love holding books. They want their kids to go to bookstores. Their kids want their parents to take them to bookstores."

Some in the industry say bookstores may serve an even more prominent role as a forum for authors and a showroom for readers seeking to discover what's new.

"Bookstores are still the best places to go for divergent ideas," says James Patterson, the best-selling author. "With fewer newspapers providing reviews, where will people go to find out about new books? Barnes & Noble will do that and give you more assistance with e-books. They have a future."

Barnes & Noble doesn't have the luxury of time. Mr. Burkle, the investor whose stake is now near 20%, has been agitating for changes in how the company is governed.

Mr. Burkle, who declined to be interviewed, is mum about his strategy. He has indicated to others that Barnes & Noble's famous brand and mint real estate locations will benefit from Borders' ongoing struggles and survive the digital tsunami.

Mr. Riggio, who owns 31% of the retailer, declined to comment on Mr. Burkle's efforts.

As for the Barnes & Noble's superstores of the future, Mr. Riggio says the retailer is experimenting with selling a variety of merchandise, including consumer electronics.

"I would say that there's nothing we wouldn't put under consideration," Mr. Riggio says, "although it's safe to say we won't have pots and pans."

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.